Working Paper: NBER ID: w8966
Authors: Michael D. Bordo; Olivier Jeanne
Abstract: The link between monetary policy and asset price movements has been of perennial interest to policy makers. In this paper we consider the potential case for pre-emptive monetary restrictions when asset price reversals can have serious effects on real output. First, we provide some historical background on two famous asset price reversals: the U.S. stock market crash of 1929 and the bursting of the Japanese bubble in 1989. We then present some stylized facts on boom-bust dynamics in stock and property prices in developed economies. We then discuss the case for a pre-emptive monetary policy in the context of a stylized 'Dynamic New Keynesian' framework with collateral constraints in the productive sector. We find that whether such a policy is warranted depends on the economic conditions in a complex, non-linear way. The optimal policy cannot be summarized by a simple policy rule of the type considered in the inflation-targeting literature.
Keywords: No keywords provided
JEL Codes: E52; N20
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| asset price reversals (G12) | serious economic downturns (F44) |
| proactive monetary policy (E63) | mitigate risks associated with asset price booms (E44) |
| unchecked booms (Q33) | subsequent busts and credit crunches (E32) |
| restrictive policies (J18) | immediate costs of lower output and inflation (E31) |
| busts (E32) | disruptions in financial and real activity (E44) |
| busts (E32) | banking crises and declines in output and inflation (F65) |